There’s a new economy emerging driven by changes in technology, demographics and the environment. This new economy requires a new finance. A new finance to serve the digital economy. A new finance with products that are more cost effective, better tailored, and more inclusive. A new finance to support the transition to a sustainable economy. A new finance that balances innovation with resilience.
With its leadership in fintech and green finance, the UK private sector is creating the new finance, but your efforts will be more effective with the right conditions in which to innovate and the level playing fields on which to compete.
The Bank of England’s strategy is to enable innovation and to empower competition, while ensuring monetary and financial stability. Our levers are the hard and soft infrastructure that we control:
- Hard infrastructure – access to our balance sheet and access to our real-time gross settlement (RTGS) system, the heart of the UK payments system.
- Soft infrastructure – rules, regulations and standards.
I would like to focus on a few of the actions that the Bank will take to enable the new economy; to ensure the resilience of the financial system; and to support the UK’s transition to a carbon-neutral economy.
The very nature of commerce is changing. Last year, one fifth of all sales in the UK were online. Next year, it will be one quarter. Over the past decade, the proportion of total payments made in cash has declined from two thirds to one quarter.
The digital economy is more inclusive, offering easier and more cost effective routes to market for firms both large and small, and greater access for consumers both near and far.
This new economy is placing new demands on finance. Consumers and businesses increasingly expect transactions to be settled in real time, checkout to become an historical anomaly, and payments across borders to be indistinguishable from those across the street. While there have been some notable successes, the UK system has a way to go before it meets these expectations.
Thus far, most innovation has happened around payment initiation – the method used to instruct a payment – such as credit or debit card, banking app or mobile wallet. There have also been some advances in the networks – or rails – that underpin some of these apps. For example, the Faster Payment System (FPS) launched a decade ago has made payments quicker (within two hours) and more cost-effective by encouraging direct bank-to-bank transfers.
While mobile app PayM uses FPS to facilitate direct bank-to-bank payments between individuals via text, it requires both the sender and recipient to be signed up to the third-party service. But few are. And FPS is not yet used for in-store or online purchases as the infrastructure required at the point of sale does not reliably exist in the UK.
In these regards, the UK is still a long way behind countries such as Sweden, the Netherlands and India where users can make direct, free and real time bank-to-bank payments in stores and online with a text or a scan of a QR code.
UK card payments are convenient and they are now the most popular means of payment, but they can cost between 0.5% and 2% of the total transaction value, and it can take three days for the merchant to receive their money.
And all these systems in the UK – whether card or bank payment – still depend on existing core infrastructure meaning they either carry the associated costs and limitations on speed or they require the right point of sale infrastructure for their full benefits to be realised.
The scope for improving cross-border payments is bigger still. These can cost up to 10 times their domestic equivalent. Anti-money laundering checks that are rightly required can be cumbersome, and settlement is slow with money taking up to a week to reach the recipient.
Most fundamentally, the new payment system must end the inequity that the people with the least money pay the most for financial services.
The revolution of payments may not be driven by the old bank-based systems but by a new architecture. Major changes are on the horizon, bringing enormous advantages but also more than a few new challenges. That’s why the Bank fully supports the Payments Strategy Review.
To support private innovation and to empower competition, the Bank is levelling the playing field between old and new. This means allowing competitors access to the same resources as incumbents while holding the same risks to the same standards.
The Bank is in the midst of an ambitious rebuild of its RTGS system, which processes £650 billion of payments on average every day. Until recently, only commercial banks had direct access to it, and alternative payment service providers (PSPs) had to route through participating banks. That made sense in the old financial world arranged around a series of hubs and spokes, but it is increasingly anachronistic in the new, distributed finance that is emerging.
So we are now making it easier for a broad set of firms to plug in and compete with more traditional providers. In July 2017, we became the first G7 central bank to open up access to our payment services to a new generation of non-bank PSPs. Since then, six have become members, processing over four million transactions over the past year. There is now a growing pipeline of 20 firms looking to join.
Responding to demands from innovators, the RTGS rebuild will also now provide API access to users to read and write payments data, as well as implementing a system whereby each payment will be tagged with information in a standardised format across the world. This global messaging standard will speed up settlement both domestically and across borders.
It is not a one-way street, however. As we extend access, we will safeguard resilience by holding settlement account holders to the appropriate standards. Along with the Financial Conduct Authority and HM Revenue and Customs, who together supervise these institutions, we are committed to applying a strengthened supervisory regime for those who apply for an RTGS settlement account, to give assurance that non-bank PSPs can safely take their place at the heart of the payment system.
We can go even further. The Bank of England plans to consult on opening access to our balance sheet to new payment providers. Historically, only commercial banks were able to hold interest-bearing deposits, or reserves, at the Bank. That reflected their role at the core of the payment system. As new payment providers and systems emerge, access to the Bank’s core infrastructure should change and it makes sense to consider whether they too can hold funds overnight on the Bank’s balance sheet.
From the Bank’s perspective, expanding access can improve the transmission of monetary policy and increase competition. It can also support financial stability by allowing settlement in the ultimate risk free asset and reducing reliance on major banks. Users should benefit from the reduced costs and increased certainty that comes with banking at the central bank.
From the perspectives of UK households and businesses, wider access can improve inclusion and services.
This access could empower a host of new innovation. In wholesale markets, consortia of broker dealers are working to develop settlement systems using distributed ledger technology that could overhaul how markets operate. These consortia, such as USC, propose to issue digital tokens that are fully backed by central bank money, allowing instant settlement. This could also plug into ‘tokenised assets’ – conventional securities also represented on blockchain—and smart contracts. This can drive efficiency and resilience in operational processes and reduce counterparty risks in the system, unlocking billions of pounds in capital and liquidity that can be put to more productive uses.
The potential transformation in retail payments is even more fundamental. A cooperative of technology companies proposed a new payments infrastructure based on an international stablecoin – Libra, which would be backed by reserve assets in a basket of currencies including sterling. It could be exchanged between users on messaging platforms and with participating retailers. As designed, Libra may substantially improve financial inclusion and dramatically lower the costs of domestic and cross-border payments.
The Bank of England approaches Libra with an open mind but not an open door. Unlike social media for which standards and regulations are being debated well after they have been adopted by billions of users, the terms of engagement for innovations such as Libra must be adopted in advance of any launch.
Libra, if it achieves its ambitions, would be systemically important. As such it would have to meet the highest standards of prudential regulation and consumer protection. It must address issues ranging from anti-money laundering to data protection to operational resilience. Libra must also be a pro-competitive, open platform that new users can join on equal terms. In addition, authorities will need to consider carefully the implications of Libra for monetary and financial stability. Our citizens deserve no less.
Leveraging our position at the heart of the international financial system and one of the world’s largest fintech hubs, the Bank of England will help lead the way on these issues at the G7, G20, the Financial Stability Board, Bank for International Settlements and the International Monetary Fund.
Whatever the fate of Libra, its creation underscores the imperative of transforming payments. The Bank’s strategy to open access to a wide range of payment solutions combined with appropriate regulatory oversight of them maximises the likelihood that the payments revolution will meet the demands of the new economy and the needs of all our citizens.
Big data is opening up new opportunities for more competitive, platform-based finance of small and medium enterprises (SMEs). Artificial intelligence (AI) and machine learning (ML) techniques are already mining fields of data generated by online activity. This has the potential to yield enormous benefits for households and businesses by opening up new lines of credit, providing greater choice, better-targeted products and keener pricing.
Putting data to work is critical to closing one of the biggest funding gaps in the country.
SMEs are the engine room of our economy, generating around 60% of all private sector employment and accounting for over half of all private business turnover. And yet SMEs face a £22 billion funding gap. Almost half of all SMEs don’t plan to use external finance, citing the hassle or time associated with applying. Of those that have approached their bank, two fifths have been rejected.
Part of the problem is that the assets that SMEs are seeking to borrow against are increasingly intangible – the value of a brand or user base – rather than physical assets, like building or machinery. SMEs that have not borrowed lack the historic data required for credit scoring. And legal requirements to prevent money laundering and ‘know your customer’ make the process especially burdensome for a small business with limited resources.
This should not be the case in a data-rich world. Lenders should be able to access a broader set of information on which to base credit decisions.
To make real inroads, SMEs must be able to identify the data relevant to their businesses, incorporate it into their individual credit files, and easily share these files with potential providers of finance through a national SME financing platform.
This would put into practice the recommendations from Professor Jason Furman’s Digital Competition Panel report on how to extract value from data and promote competition. One of the most important recommendations in this regard is to give consumers control of their data. This would allow consumers to move their personal information from one platform to another and avoid lock-in effects, opening the door to new services. To some extent, this is what Open Banking hopes to achieve. Although to make this a success means establishing common off the-shelf API standards and operating platforms onto which developers can build.
An open platform for SME lending would enable open banking and empower SMEs. It would help avoid lock-in on existing platforms and enable providers of finance to compete for SME lending, helping to broaden the products available to companies and offer more competitive rates, making access to finance quick, easy and cost effective.
It is not for the Bank of England to build this platform but we can help lay some of groundwork. The messaging standards we are adopting in the new RTGS will also include tagging payments with a legal entity identifier (LEI). This will be mandated for financial institutions and as a next step we are considering how to extend this to corporate payments. That could mean that the payment data sent via CHAPS of non-financial firms could be made available for inclusion in a portable credit file. The LEI could also act as the unique identifier for a digital ID, which could help the two-step verification process required for a secure system.
Today the key competitive advantage in financial services is how firms – and supervisors—collect, store and analyse the explosion of data. Just as the steam engine transformed manufacturing, AI, ML and cloud-based technologies are transforming services.
Embracing these technologies could herald leaner, faster and more tailored financial services. Banking is already the second biggest global spender on AI systems (after retail) and the sector is expected to invest a further $6 billion on AI this year.
A quarter of major banks’ activities and almost a third of all UK payments activity are already hosted on the cloud, and there are considerable opportunities for even more intensive usage. If deployed at scale, cloud technology could provide low-cost, resilient computing power and easy access to AI capabilities, unlocking 30-50% unit cost savings. These savings can be passed onto customers and, if properly managed, improve the resilience of the overall system. For these reasons, the Bank of England is open to greater adoption of the cloud and usage of AI. This means ensuring that these technologies are adopted in a safe manner, in ways that increase resilience.
Careful attention will have to be given to risks, including of those associated in the single point of failure and market concentration. Two providers account for nearly half of revenues in cloud computing, bringing scale and efficiency, but also concerns about dependence and a single point of failure in the case of a cyber attack. In AI and ML, there is a reliance on data, but when there are biases in data or algorithms, or the situation isn’t captured by past experience prediction becomes difficult and judgement becomes more important. These situations require robust governance at board level.
The Bank’s management and analysis of data is critical to our effectiveness as regulators and to the City’s competitiveness. The Bank now receives 65 billion data points each year of firm-related information. To put that into context, reviewing it all would be the equivalent of each supervisor reading the complete works of Shakespeare twice a week, every week of the year.
For firms, while the cloud and AI have reduced the costs of storage and analysis, producing regulatory submissions is still labour intensive and costs the industry an estimated £2-4.5 billion per year. This is the new frontier of regulatory efficiency and effectiveness. The Prudential Regulation Authority is exploring how new technologies could streamline firms’ compliance and regulatory processes while improving our ability to analyse relevant data.
The PRA Rule Book is longer than War and Peace. It is also somewhat less interesting and infinitely more complex. We are currently using advanced analytics to understand that complexity and to simplify our rules in order to make compliance with them easier and less expensive.
An even bigger opportunity lies in the Bank rethinking completely how we collect, store and analyse data. We cannot do this in isolation but will engage with industry to explore a range of options.
Our vision is that the Bank could be able to ‘pull the data on demand’ from firms rather than ‘sit back and wait to receive data’ from them. With the right application programming interface, web portal or platform, manual interventions could become obsolete, making the process quicker, more efficient and hugely less expensive. It would free-up resources for firms to focus on delivering a better service to their customers, and it could discipline us to take only the data that we need to use and have the capacity to review.
Equally important, utilising ML and AI to analyse the data could free up supervisors’ time to add the greatest value where humans excel over machines: judgement.